A MORIBUND WORLD ECONOMY: A BALANCE OF PAYMENTS ANALYSIS OF WHO THE CULPRITS ARE; WHAT ARE THE CAUSES ANDWHY IT IS SO
The finger pointing mounts, but
only results in further confusion
Some analysts claim that the major cause of the slowing in the growth
of the world’s economy is primarily attributable to Mainland China’s
slowdown. Others argue it has to do with
nations depreciating their currencies in foreign exchange markets as occurred
during the “Great Depression of the 1930s. Environmentalists state it is all
due to fracking. Then of course, there
are the wishful thinkers that believe that that all is fine on all fronts:
situation normal. Could it at least be
in part due to the fact that largest economy in the world, the U.S. of A., is
stagnating, or has just been limping along at a subpar rate of growth for the
past several years? Perish the
another Long gone Policy; or is it Alive and Well?
Maybe it is time to integrate the lessons of history into an analysis
of this global slowdown in economic growth.
A good starting point would be a brief review of the rise of Mercantilism around the 16th
Century as feudalism was coming to an end in many places, although some might
argue its vestiges continue on in parts of the world even now.
A dominant tool of mercantilist policy was for a political entity, such
as a nation seeking to expand its territorial limits, to generate a trade
surplus by exporting more than it imported. If imports such as cotton were to be re-exported as cotton clothing, that trade
was acceptable; but if not, imports were usually frowned upon. In the Balance
of Payments Accounts (BOPA) terminology, a trade surplus is a surplus in
the combined Goods and Services Account (the Goods Account was often referred
to as the Merchandise Account in the past).
The term surplus in this context means that the exports exceeded the
imports of the nation in question. If Nation A, for example, has a surplus in
its trade balance (same as its combined Goods and Services Balance) with Nation
B, Nation B must for the same period of time have a deficit in that balance
with Nation A.
To the extent needed, we will examine the Balance of Payments Accounts
and the determination of exchange rates to help lift the fog of confusion that
abounds in the area of international economic and financial interrelationships
between the nations of the world.
Two prices in international trade: price of the good or service; and the price
of the currency
What makes analysis of the behavior of the world economy so difficult
is that the international markets, with the exception of such things as swaps;
two prices are involved, not just one price as in the case in purely domestic
transactions. In international transactions,
there is a second price beyond the price of the good or service involved; that
of the price of the currency of the other nations, called the exchange
rate. This is a necessity; whether to
import merchandise/goods or services from other nations, give them governmental
aid or private remittances, or invest long-term or short-them in those
We now turn to a brief review of the balance of payments accounts
(BOPA) and its usefulness as an analytical tool.
The Balance of Payments Accounts (BOPA) is a double entry bookkeeping
system similar to the National Income and Product Accounts (NIPA). The BOPA measures all of these international
transactions and organizes these transactions into five categories: 1) Merchandise
or Goods, 2) Services, 3) Unilateral Transfers, 4) Long-term Capital; and 5) Short-term
Capital transactions. It can measure not
only transactions between two nations, but also between one nation and one
region such as the European Union, or one nation with all other nations of the
Each of the five accounts in the Balance of Payments has a balance such
as U.S. Exports of Goods (or Merchandise) minus U.S. Imports of Goods (or
Merchandise) which is referred to as the Balance on Goods Account. The transactions, such as involved in the importation
of goods causes a demand for foreign currency while exports of goods are a
source of the supply of foreign currency.
For this reason, each of the five accounts also has two sides, debits and
credits in an accounting sense of these terms.
It’s important to note that each of the five accounts by themselves
need not balance. They can have a surplus or a deficit balance. However, if all five accounts are combined,
the sum of their balances must equal zero unless bookkeeping errors are made or
transactions are incorrectly estimated.
That is why the term discrepancy is found in these accounts due to the
fact that many of the transactions are deliberately hidden to avoid prosecution
or embarrassment to those engaged in the transactions. Money laundering is one such example of
transactions difficult to estimate correctly.
The recent release of the so called Panama Papers reveals that enormous
sums are involved even from officials in Communist nations such as Mainland
China, no doubt for the betterment of the proletarian masses (hmmmm).
“A study by Andy Yan, an urban planning researcher and adjunct professor at the
University of British Columbia, of real estate sales in Vancouver—also thought
to be affected by foreign purchasers—found that 18% of the transactions in
Vancouver's most expensive neighborhoods were cash purchases, and 66% of the
owners appeared to be Chinese nationals or recent arrivals from China. Calls for more data on foreign investors have
been rejected by the provincial government.
Chinese nationals accounted for 70% of 2014 Vancouver home sales over $3
A deficit in an account such as the Long-Term Capital Account would
contribute to a net demand for the foreign currency or currencies
involved. For example if for the period
of time being considered, U.S. long-term investments outside the U.S. are
greater than foreign long-term investments in the U.S. it would be termed a deficit on long-term
Capital Account and contribute to the depreciation of the dollar, all else
Remember that when the dollar depreciates, the dollar prices of foreign
currencies involved increase. If foreign
long-term investment in the U.S. is greater in a time period than is U.S.
long-term investment outside the U.S. it constitutes a net demand for the U.S. dollar,
all else equal, and the dollar appreciates causing foreign currencies to be
cheaper in dollar terms.
A surplus in a nation’s merchandise/goods account would tend to cause
that nation’s currency to appreciate or experience an increase in its price in
terms of the currency of the nation with the deficit in that account. Now we are able to see the relationship of a
nation’s BOPA to foreign exchange markets.
As the dollar appreciates, foreign goods or merchandise, services,
unilateral transfers, and capital investments become cheaper in dollar terms,
all else equal. As the dollar
depreciates, the opposite effect occurs.
Of course, nations and their central banks can intervene directly in
the foreign exchange markets as they often do, whether it’s the Bank of Japan,
European Central Bank, Peoples Bank of China, etc. Selling a nation’s currency tends to
depreciate it and buying its own currency with foreign currencies tends to
appreciate the nation’s currency.
Chinese Spending Abroad
Panama Papers give evidence that the flight out of a currency such as the Chinese
Yuan tends to have the effect of depreciating that currency just as if its
central bank had dumped its currency on foreign exchange markets. From recent reports, the end result of the
Chinese currency sellers was rising prices in England with property in places
like the Brighton area experiencing a 500% increase in values.
In carrying out these transactions, the UK Pound tended to appreciate
as the Yuan depreciated. While these
transactions may raise the spirits of wishful thinkers, perhaps it does little
to help raise the rate of economic growth.
It is much more likely that it reflects a declining faith in the holding
of assets within Mainland China or because of the potential collapse of
investments within the Peoples’ Republic due to a very weak consumer demand by
the proletarian masses. The true
economic reality is a portrayal of real life often masked by the fairy tales of
the wishful thinkers.
the Mercantilist era, imbalances in the trade balance would be ‘settled’ by
flows on money or precious metals and enhanced the ability of the nation with
the surplus in its trade balance to do such things as pay mercenaries to help
fight wars of territorial conquest as the British did with Hessian soldiers in
e.g., in their war with their then colonies in North America. You might recall that George Washington began
to turn the Revolutionary war around by defeating the Hessian mercenaries who
were employed by Britain at the Battle of Trenton and was immortalized in the
picture of Washington crossing the Delaware River.
Nowadays the motivation is different and this practice of developing a
surplus in a nation’s trade balance becomes a way for a nation to stimulate its
level of economic activity. Some apply
the term Neo-Mercantilism to a nation such as Mainland China which seems to
promote this tendency to experience trade balance surpluses.
Of course, the nations in such a relationship experiencing a deficit in
their trade balance, such as the U.S., would experience a drag or depressing
effect on their level of economic activity.
along with the uncertainty to potential employers arising from the so-called
Affordable Health Care Act and presidential decrees replacing Congressional
legislative actions have made capital investments by business too risky, as is
seen in the underlying data for the first quarter of 2016 as just recently reported
by the U.S. Bureau of Economic Analysis.
Recall that in order to rebuild Europe and Japan after WWII the Bretton
Woods IMF Fixed Exchange Rate System (https://en.wikipedia.org/wiki/International_Monetary_Fund) deliberately
overpriced the U.S. dollar as one way to help stimulate Europe and Japan back on
the road to recovery from the devastation wrought by WWII. The success of the post-World War II recovery
reflected the fact that we had learned a lesson from the failure to help bring
about a recovery after the First World War.
The combination of the over valuation of the dollar in the Bretton Woods
IMF Fixed Exchange Rate System and the Marshall Plan were among the primary
causes of the successful Post-WWII recovery.
The current attempt by nations to achieve a trade balance surplus
through exchange rate manipulation has no such noble justification.
While in current times the motivation is different than in the heyday
of Mercantilism, the policy is the same. A surplus in its combined Merchandise/Goods
and Services Accounts stimulates that nation’s level of real economic activity
by increasing its aggregate demand (AD).
In the parlance of the NIPA, it is termed Net Exports of Goods and
Services and is one of the four components of AD. The other components of (AD) in the NIPA are
Personal Consumption Expenditures, Gross Private Domestic Investment, and
Government Expenditures on Goods and Services.
This is the major route or connection between international
transactions and the level of domestic economic activity of the nations
involved. Now you can see why some
nations utilize policies to generate and enhance a surplus in their trade
balance – case in point, Mainland China, which has been pursuing for many
years. If China’s personal consumption
and investment portions of AD are insufficient to keep the labor force
employed, currency depreciation is an alternative policy. The millions displaced by the construction of
the Three Gorges Dam and the 86 million ‘Population Police’ used to enforce the
now abandoned One Child policy rank right up there with Khrushchev’s wasteful
spending on the ‘Virgin Lands’ project of the Communist led Soviet Union (https://en.wikipedia.org/wiki/Virgin_Lands_Campaign
) and do little to enable the proletariat to be able to demand consumer
In effect, the policy of Mainland China is to replace a large part of its weak
domestic consumer demand with that of the expropriation of some of the U.S.
Personal Consumption Expenditure demand.
The serious drawback of this policy for the U.S. is that in conjunction
with the uncertainty of such policy as presidential edicts and the Affordable
Healthcare Act, this channels a significant part of the U.S. consumer spending
toward imports from the Peoples’ Republic of China away from domestic aggregate
The use of a trade surplus in order to stimulate a nation’s overall
level of economic activity is referred to by some as a neo-mercantilist policy
nation. The difference is that a
macroeconomic goal is targeted instead of a more microeconomic oriented
political goal which dominated the original mercantilist period of nation building.
This has been a policy of Mainland China for many years as weak
domestic consumption and at times investment, cause a shortfall fall in respect
to a full employment level of GDP even with government spending added in. This form of neo-mercantilism uses the same
policies but has different ends such as increases in a nation’s aggregate
demand in order to increase jobs that a purely domestic aggregate demand could
Modern day Beggaring thy
Neighbor and protecting domestic jobs
Since the exchange rate can be manipulated to depreciate a nation’s
currency and make its exports of goods and services cheaper to buyers in other
nations, it is often resorted to as a part of a nation’s economic policy
initiatives. This has been a substantial
part of the so called ‘Chinese miracle’.
Of course it means that nations such as the U.S. are the victim since
the Mainland China trade balance surplus with the U.S. is a trade balance deficit
for the U.S. with the Peoples’ Republic of China.
As pointed out earlier in this newsletter, the use of trade balance
deficits that aid other nations is not new to the U.S. of A. This practice was institutionalized in the
Bretton Woods Fixed Exchange Rate System (https://en.wikipedia.org/wiki/Bretton_Woods_system) that lasted from
about 1945 to around 1970. The
exchange rates were fixed and occasionally adjusted to deliberately value the
dollar above its equilibrium level. This
made the currencies of many nations including Japan and Germany priced or
valued less than their equilibrium levels.
Market intervention by these nations kept the dollar overvalued or
overpriced and the currencies of the other nations underpriced or
undervalued. In fact it was incumbent on
those nations to intervene in the foreign exchange markets to make it so. While
the effect was the same, the IMF Breton Woods Fixed Exchange Rate System was
agreed to by a willing U.S. of A., contrary to the one-sided decision of
Mainland China, as is the case now and has been the case for many years.
The more recent ‘Beggar Thy Neighbor’ policies (https://en.wikipedia.org/wiki/Beggar_thy_neighbour),
such as that of the Peoples Republic of China, have been one sided decisions
which deliberately depreciated currencies such as the (Chinese) Yuan. You can think of these government policies as
a generalized form of dumping. Dumping
is the practice of individual firms selling their products abroad at
significantly lower prices than in their own domestic market. If the currencies of the nations involved become
cheaper, while domestic prices of the products in those nations stay the same,
the effective price to foreign importers falls and it tends to increase the
exports of the nation depreciating their currencies. At the same time this decreases the imports
to the nations depreciating their currencies in foreign exchange markets. This in turn increases the AD (aggregate
demand) of the nation depreciating its currency. Given this fairly widespread practice of
several nations in recent years, such policies of foreign governments that are
major trading partners of the U.S. have been one of the contributing factors of
the economic slowdown in the U.S.
redressing the trade imbalances?
you are wondering what can be done to correct this tendency that is one of the
factors currently depressing the level of economic activity and its growth rate
in recent years, the answer is: plenty.
Direct our central bank to sell dollars and buy foreign currency of
nations that have adopted this policy of ‘beggaring their neighbors’’ instead
of mending their own economy and/or political systems that have brought on
There is an old expression to which our policy makers should give more
credence: “fooled once, shame on you, fooled twice, shame on me.”
Here’s a look at the second portion of that price in
international trade, the foreign exchange rate.
You’ll note that most all of our trading partners have set about
depreciating or devaluing their currency relative to the dollar. The only way this is really sustainable is if
the domestic U.S. economy is expanding quickly enough to mitigate the negative effects
of that the imports have on growth.